Ebook Accounting principles (12/E): Part 2

Part 2 book “Accounting principles” has contents: Long-Term liabilities, financial statement analysis, managerial accounting, job order costing, process costing, budgetary planning, budgetary control and responsibility accounting, incremental analysis and capital budgeting, standard costs and balanced scorecard,… and other contents.

Van Meter Inc., an electrical-parts distributor in Cedar Rapids,

Iowa, is 100% employee-owned For many years, the

company has issued bonuses in the form of shares of

company stock to all of its employees These bonus

distributions typically have a value equal to several weeks of

pay Top management always thought that this was a great

program Therefore, it came as quite a surprise a few years

ago when an employee stood up at a company-wide meeting

and said that he did not see any real value in receiving the

company’s shares Instead, he wanted “a few hundred extra

bucks for beer and cigarettes.”

As it turned out, many of the company’s 340 employees felt

this way Rather than end the stock bonus program, however,

the company decided to educate its employees on the value

of share ownership The employees are now taught how to

determine the worth of their shares, the rights that come with

share ownership, and what they can do to help increase the

value of those shares

As part of the education program, management developed a

slogan, “Work ten, get fi ve free.” The idea is that after

working 10 years, an employee’s shares would be worth the

equivalent of about fi ve years’ worth of salary For example, a

person earning a $30,000 salary would earn $300,000 in wages over a 10-year period During that same 10-year

period, it was likely that the value of the employee’s shares would accumulate to about $150,000 (fi ve years’ worth of

salary) This demonstrates in more concrete terms why employees should be excited about share ownership

A 12-member employee committee has the responsibility of educating new employees about the program The committee also runs training programs so that employees understand

how their cost-saving actions improve the company’s results— and its stock price It appears that the company’s education

program to encourage employees to act like owners is working Profi tability has increased rapidly, and employee

turnover has fallen from 18% to 8% Given Van Meter’s

success, many of the 10,000 other employee-owned companies in the United States might want to investigate whether their employees understand the benefi ts of share ownership

Source: Adapted from Simona Covel, “How to Get Workers to Think and Act Like Owners,” Wall Street Journal Online (February 15, 2008).

Owning a Piece of the Action

As indicated in the Feature Story below, a profi table corporation like

learn more about the role of dividends, retained earnings, and earnings per share, they develop an understanding and appreciation for what the company is providing to them.

CHAPTER PREVIEW

14

FEATURE STORY

Corporations: Dividends, Retained Earnings, and Income Reporting

608

Describe the form and content of corporation income statements.

Prepare and analyze a comprehensive stockholders’ equity section.

3

4

Explain how to account for cash dividends.

Stock Dividends and Stock Splits

• Income statement presentation

• Income statement analysis

CHAPTER OUTLINE

Explain how to account for stock dividends and splits.

2 • Stock dividends• Stock splits

Go to the REVIEW AND PRACTICEsection at the end of the chapter for a review of key concepts and practice

applications with solutions

Visit WileyPLUS with ORION for additional tutorials and practice opportunities.

1 Explain how to account for cash dividends.

LEARNING

OBJECTIVE

A dividend is a corporation’s distribution of cash or stock to its stockholders

on a pro rata (proportional to ownership) basis Pro rata means that if you

own 10% of the common shares, you will receive 10% of the dividend Dividends can take four forms: cash, property, scrip (a promissory note to pay cash), or stock Cash dividends predominate in practice although companies also declare stock dividends with some frequency These two forms of dividends are therefore the focus of discussion in this chapter.

Investors are very interested in a company’s dividend practices In the fi

nan-cial press, dividends are generally reported quarterly as a dollar amount per share (Sometimes they are reported on an annual basis.) For example, Nike ’s

quarterly dividend rate in the fourth quarter of 2013 was 24 cents per share The

dividend rate for the fourth quarter of 2013 for GE was 22 cents, and for ConAgra Foods it was 25 cents.

Cash Dividends

A cash dividend is a pro rata distribution of cash to stockholders Cash dends are not paid on treasury shares For a corporation to pay a cash dividend,

divi-it must have the following.

1 Retained earnings The legality of a cash dividend depends on the laws of the

state in which the company is incorporated Payment of cash dividends from retained earnings is legal in all states In general, cash dividend distributions from only the balance in common stock (legal capital) are illegal.

A dividend declared out of paid-in capital is termed a liquidating dend Such a dividend reduces or “liquidates” the amount originally paid in by stockholders Statutes vary considerably with respect to cash dividends based

divi-on paid-in capital in excess of par or stated value Many states permit such dividends.

2 Adequate cash The legality of a dividend and the ability to pay a dividend

are two different things For example, Nike , with retained earnings of over

$5.6 billion, could legally declare a dividend of at least $5.6 billion But Nike’s

cash balance is only $3.3 billion.

Before declaring a cash dividend, a company’s board of directors must carefully consider both current and future demands on the company’s cash

resources In some cases, current liabilities may make a cash dividend propriate In other cases, a major plant expansion program may warrant only

inap-a relinap-atively sminap-all dividend.

3 Declared dividends A company does not pay dividends unless its board of

directors decides to do so, at which point the board “declares” the dividend The board of directors has full authority to determine the amount of income

to distribute in the form of a dividend and the amount to retain in the ness Dividends do not accrue like interest on a note payable, and they are not

busi-a libusi-ability until declbusi-ared.

The amount and timing of a dividend are important issues for management

to consider The payment of a large cash dividend could lead to liquidity lems for the company On the other hand, a small dividend or a missed dividend may cause unhappiness among stockholders Many stockholders expect to receive

prob-a reprob-asonprob-able cprob-ash pprob-ayment from the compprob-any on prob-a periodic bprob-asis Mprob-any compprob-a- nies declare and pay cash dividends quarterly On the other hand, a number of high-growth companies pay no dividends, preferring to conserve cash to fi nance future capital expenditures.

compa-ENTRIES FOR CASH DIVIDENDS

Three dates are important in connection with dividends: (1) the declaration date,

(2) the record date, and (3) the payment date Normally, there are two to four

weeks between each date Companies make accounting entries on the declaration

date and the payment date.

On the declaration date , the board of directors formally declares

(autho-rizes) the cash dividend and announces it to stockholders The declaration of a

cash dividend commits the corporation to a legal obligation The company

must make an entry to recognize the increase in Cash Dividends and the increase

in the liability Dividends Payable.

To illustrate, assume that on December 1, 2017, the directors of Media

Gen-eral declare a 50 cents per share cash dividend on 100,000 shares of $10 par value

common stock The dividend is $50,000 (100,000 3 $0.50) The entry to record

the declaration is as follows.

Declaration Date

(To record declaration of cash dividend)

Media General debits the account Cash Dividends Cash dividends decrease

retained earnings We use the specifi c title Cash Dividends to differentiate it from

other types of dividends, such as stock dividends Dividends Payable is a current

liability It will normally be paid within the next several months For homework

problems, you should use the Cash Dividends account for recording dividend

declarations.

At the record date , the company determines ownership of the outstanding

shares for dividend purposes The stockholders’ records maintained by the

cor-poration supply this information In the interval between the declaration date

and the record date, the corporation updates its stock ownership records For

Media General, the record date is December 22 No entry is required on this

date because the corporation’s liability recognized on the declaration date is

unchanged.

Record Date

On the payment date , the company makes cash dividend payments to the

stockholders of record (as of December 22) and records the payment of the

divi-dend If January 20 is the payment date for Media General, the entry on that date

is as follows.

Payment Date

(To record payment of cash dividend)

Note that payment of the dividend reduces both current assets and current

liabil-ities It has no effect on stockholders’ equity The cumulative effect of the

decla-ration and payment of a cash dividend is to decrease both stockholders’ equity

and total assets Illustration 14-1 (page 612) summarizes the three important

dates associated with dividends for Media General.

Helpful Hint

The purpose of the record date is to identify the per-sons or entities that will receive the dividend, not

to determine the amount

of the dividend liability

250,000 Div150,000

Cash Flows

no effect

250,000250,000

Cash Flows

250,000

When using a Cash Dividends account, Media General should transfer the balance of that account to Retained Earnings at the end of the year by a closing entry The entry for Media General at closing is as follows.

(To close Cash Dividends to Retained Earnings)

Dividend Preferences Preferred stockholders have the right to receive dividends before common stockholders For example, if the dividend rate on preferred stock is $5 per

share, common shareholders cannot receive any dividends in the current year until preferred stockholders have received $5 per share The fi rst claim to divi-

dends does not, however, guarantee the payment of dividends Dividends depend

on many factors, such as adequate retained earnings and availability of cash If a company does not pay dividends to preferred stockholders, it cannot pay divi- dends to common stockholders.

For preferred stock, companies state the per share dividend amount as a centage of the par value or as a specifi ed amount For example, Earthlink speci-

per-fi es a 3% dividend on its $100 par value preferred PepsiCo pays $4.56 per share

on its no-par value stock.

Most preferred stocks also have a preference on corporate assets if the poration fails This feature provides security for the preferred stockholder The preference to assets may be for the par value of the shares or for a specifi ed liquidating value For example, Commonwealth Edison ’s preferred stock enti- tles its holders to receive $31.80 per share, plus accrued and unpaid dividends,

cor-in the event of liquidation The liquidation preference establishes the respective claims of creditors and preferred stockholders in litigation involving bank- ruptcy lawsuits.

CUMULATIVE DIVIDEND

Preferred stock often contains a cumulative dividend feature This feature ulates that preferred stockholders must be paid both current-year dividends and any unpaid prior-year dividends before common stockholders are paid dividends When preferred stock is cumulative, preferred dividends not declared in a given

stip-period are called dividends in arrears.

To illustrate, assume that Scientifi c Leasing has 5,000 shares of 7%, $100 par value, cumulative preferred stock outstanding Each $100 share pays a $7 divi- dend (.07 3 $100) The annual dividend is $35,000 (5,000 3 $7 per share) If dividends are two years in arrears, preferred stockholders are entitled to receive the dividends shown in Illustration 14-2.

Boardauthorizesdividends

Record date

Registered shareholdersare eligible for dividend

Payment date

The companyissues dividend checks

The company cannot pay dividends to common stockholders until it pays the

entire preferred dividend In other words, companies cannot pay dividends to

common stockholders while any preferred dividends are in arrears.

Dividends in arrears are not considered a liability No obligation exists until

the board of directors formally declares that the corporation will pay a

divi-dend However, companies should disclose in the notes to the fi nancial statements

the amount of dividends in arrears Doing so enables investors to assess the

poten-tial impact of this commitment on the corporation’s fi nancial position.

The investment community does not look favorably on companies that are

unable to meet their dividend obligations As a fi nancial offi cer noted in

discuss-ing one company’s failure to pay its cumulative preferred dividend for a period of

time, “Not meeting your obligations on something like that is a major black mark

on your record.”

ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON STOCK

As indicated, preferred stock has priority over common stock in regard to dividends

Holders of cumulative preferred stock must be paid any unpaid prior-year dividends

and their current year’s dividend before common stockholders receive dividends.

To illustrate, assume that at December 31, 2017, IBR Inc has 1,000 shares of

8%, $100 par value cumulative preferred stock It also has 50,000 shares of $10

par value common stock outstanding The dividend per share for preferred stock

is $8 ($100 par value 3 8%) The required annual dividend for preferred stock is

therefore $8,000 (1,000 shares 3 $8) At December 31, 2017, the directors declare

a $6,000 cash dividend In this case, the entire dividend amount goes to preferred

stockholders because of their dividend preference The entry to record the

decla-ration of the dividend is as follows.

Dividendinarrears

Currentdividend

Payment of a cumulative dividend

Because of the cumulative feature, dividends of $2 ($8 2 $6) per share are in

arrears on preferred stock for 2017 IBR must pay these dividends to preferred

stockholders before it can pay any future dividends to common stockholders

IBR should disclose dividends in arrears in the fi nancial statements.

At December 31, 2018, IBR declares a $50,000 cash dividend The allocation

of the dividend to the two classes of stock is as follows.

(To record declaration of cash dividends of

$10,000 to preferred stock and $40,000

to common stock)

26,000 Div16,000

Cash Flows

no effect

Illustration 14-3

Allocating dividends to preferred and common stock

Allocated to preferred stock

Dividends in arrears, 2017 (1,000 3 $2) $2,000

2018 dividend (1,000 3 $8) 8,000 10,000

Remainder allocated to common stock $40,000

The entry to record the declaration of the dividend is as follows.

250,000 Div150,000

Cash Flows

no effect

If IBR’s preferred stock is not cumulative, preferred stockholders receive

only $8,000 in dividends in 2018 Common stockholders receive $42,000.

Investor Insight

Dividends in Demand

Investors seeking dividend income enjoyed a great year in 2013 A total of 418 companies in

the Standard & Poor’s 500 index paid a dividend, matching the highest total since 1998 As

shown in the following chart, dividend growth since 2008 more than doubled

And for holders of dividend-paying stocks, corporate America may continue to sweeten the pot One reason for optimism is that the average dividend payout—the percentage of corporate profi ts paid out as dividends—remains low at 36% The historical average is 52%

Source: Trevor Delaney and Jenni Sohn, “Dividends in Demand” Naples Daily News (January 8, 2014), p 5B.

What factors must management consider in deciding how large a dividend to pay? (Go to

WileyPLUS for this answer and additional questions.)

200850100150200250300350400

0

2009 2010 2011 2012 2013

Increases and initiationsDecreases and suspensions

S&P 500 Dividend Actions

Palto/iStockphoto

MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock standing at December 31, 2017 At December 31, 2017, the company declared a $60,000 cash dividend Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios

out-1 The preferred stock is noncumulative, and the company has not missed any dividends

in previous years

2 The preferred stock is noncumulative, and the company did not pay a dividend in

each of the two previous years

3 The preferred stock is cumulative, and the company did not pay a dividend in each of

the two previous years

Solution

DO IT! 1 Dividends on Preferred and Common Stock

1 The company has not missed past dividends and the preferred stock is

noncumu-lative Thus, the preferred stockholders are paid only this year’s dividend The

dividend paid to preferred stockholders would be $12,000 (2,000 3 06 3 $100) The dividend paid to common stockholders would be $48,000 ($60,000 2 $12,000)

Action Plan

✔ Determine dividends

on preferred shares

by multiplying the

dividend rate times the

par value of the stock

times the number of

preferred shares.

2 Explain how to account for stock dividends and splits.

LEARNING

OBJECTIVE

Stock Dividends

A stock dividend is a pro rata (proportional to ownership) distribution of the

corporation’s own stock to stockholders Whereas a company pays cash in a cash

dividend, a company issues shares of stock in a stock dividend A stock dividend

results in a decrease in retained earnings and an increase in paid-in capital

Unlike a cash dividend, a stock dividend does not decrease total stockholders’

equity or total assets.

To illustrate, assume that you have a 2% ownership interest in Cetus Inc That

is, you own 20 of its 1,000 shares of common stock If Cetus declares a 10% stock

dividend, it would issue 100 shares (1,000 3 10%) of stock You would receive

two shares (2% 3 100) Would your ownership interest change? No, it would

remain at 2% (22 4 1,100) You now own more shares of stock, but your

own-ership interest has not changed.

Cetus has disbursed no cash and has assumed no liabilities What, then, are

the purposes and benefi ts of a stock dividend? Corporations issue stock dividends

generally for one or more of the following reasons.

1 To satisfy stockholders’ dividend expectations without spending cash.

2 To increase the marketability of the corporation’s stock When the number of

shares outstanding increases, the market price per share decreases

Decreas-ing the market price of the stock makes it easier for smaller investors to

pur-chase the shares.

3 To emphasize that a company has permanently reinvested in the business

a portion of stockholders’ equity, which therefore is unavailable for cash

dividends.

When the dividend is declared, the board of directors determines the size of

the stock dividend and the value assigned to each dividend.

Generally, if the company issues a small stock dividend (less than 20–25%

of the corporation’s issued stock), the value assigned to the dividend is the fair

value (market price) per share This treatment is based on the assumption that

a small stock dividend will have little effect on the market price of the shares

previously outstanding Thus, many stockholders consider small stock

divi-dends to be distributions of earnings equal to the market price of the shares

distributed If a company issues a large stock dividend (greater than 20–25%),

the price assigned to the dividend is the par or stated value Small stock

divi-dends predominate in practice Thus, we will illustrate only entries for small

stock dividends.

2 The preferred stock is noncumulative Thus, past unpaid dividends do not have to

be paid The dividend paid to preferred stockholders would be $12,000 (2,000 3

.06 3 $100) The dividend paid to common stockholders would be $48,000

($60,000 2 $12,000)

3 The preferred stock is cumulative Thus, dividends that have been missed

(divi-dends in arrears) must be paid The dividend paid to preferred stockholders would

be $36,000 (3 3 2,000 3 06 3 $100) Of the $36,000, $24,000 relates to dividends

in arrears and $12,000 relates to the current dividend on preferred stock The

div-idend paid to common stockholders would be $24,000 ($60,000 2 $36,000)

Action Plan (cont’d)

✔ Understand the cumulative feature

If preferred stock is cumulative, then any missed dividends (dividends in arrears) and the current year’s dividend must be paid to preferred stockholders before dividends are paid to common stockholders.

Related exercise material: BE14-2, E14-2 and DO IT! 14-1.

ENTRIES FOR STOCK DIVIDENDS

To illustrate the accounting for small stock dividends, assume that Medland ration has a balance of $300,000 in retained earnings It declares a 10% stock divi- dend on its 50,000 shares of $10 par value common stock The current market price

Corpo-of its stock is $15 per share The number Corpo-of shares to be issued is 5,000 (10% 3 50,000) Therefore, the total amount to be debited to Stock Dividends is $75,000 (5,000 3 $15) The entry to record the declaration of the stock dividend is as follows.

Medland debits Stock Dividends for the market price of the stock issued ($15 3 5,000) (Similar to Cash Dividends, Stock Dividends decrease retained earnings.) Medland also credits Common Stock Dividends Distributable for the par value of the dividend shares ($10 3 5,000) and credits Paid-in Capital in Excess of Par—

Common Stock for the excess of the market price over par ($5 3 5,000).

Common Stock Dividends Distributable is a stockholders’ equity account

It is not a liability because assets will not be used to pay the dividend If the pany prepares a balance sheet before it issues the dividend shares, it reports the distributable account under paid-in capital as shown in Illustration 14-4.

Paid-in Capital in Excess of Par—Common Stock 25,000 (To record declaration of 10% stock dividend)

Common Stock Dividends Distributable 50,000

Common stock dividends distributable 50,000

Paid-in capital in excess of par—common stock 25,000

When Medland issues the dividend shares, it debits Common Stock dends Distributable and credits Common Stock, as follows.

275,000 Div150,000 CS125,000 CS

Cash Flows

no effect

EFFECTS OF STOCK DIVIDENDS How do stock dividends affect stockholders’ equity? They change the composi- tion of stockholders’ equity because they transfer a portion of retained earnings

to paid-in capital However, total stockholders’ equity remains the same Stock

dividends also have no effect on the par or stated value per share, but the number

of shares outstanding increases Illustration 14-5 shows these effects for Medland.

Illustration 14-5

Dividend Change Dividend

Stockholders’ equity

Paid-in capital Common stock, $10 par $ 500,000 $ 50,000 $ 550,000 Paid-in capital in excess of par — 25,000 25,000 Total paid-in capital 500,000 175,000 575,000

Cash Flows

no effect

In this example, total paid-in capital increases by $75,000 (50,000 shares 3 10% 3

$15) and retained earnings decreases by the same amount Note also that total

stockholders’ equity remains unchanged at $800,000 The number of shares

increases by 5,000 (50,000 3 10%).

Stock Splits

A stock split , like a stock dividend, involves issuance of additional shares to

stock-holders according to their percentage ownership However, a stock split results

in a reduction in the par or stated value per share The purpose of a stock split

is to increase the marketability of the stock by lowering its market price per share

This, in turn, makes it easier for the corporation to issue additional stock.

The effect of a split on market price is generally inversely proportional to

the size of the split For example, after a 2-for-1 stock split, the market price of

Nike ’s stock fell from $111 to approximately $55 The lower market price

stimu-lated market activity Within one year, the stock was trading above $100 again

Illustration 14-6 shows the effect of a 4-for-1 stock split for stockholders.

Paid-in capital in excess of par –0– –0–

Total paid-in capital 500,000 $ 0 500,000

balances in stockholders’

equity

In a stock split, the company increases the number of shares in the same

proportion that par or stated value per share decreases For example, in a 2-for-1

split, the company exchanges one share of $10 par value stock for two shares of

$5 par value stock A stock split does not have any effect on total paid-in

cap-ital, retained earnings, or total stockholders’ equity However, the number of

shares outstanding increases, and par value per share decreases Illustration 14-7

shows these effects for Medland Corporation, assuming that it splits its 50,000

shares of common stock on a 2-for-1 basis.

Illustration 14-6

Effect of stock split for stockholders

10shares

10shares10shares

10shares

160 shares now, but I stillown only 1/4 of the company!”

Number of shares owned increases, butpercentage of company owned remains the same

A stock split does not affect the balances in any stockholders’ equity accounts

Therefore, a company does not need to journalize a stock split.

Illustration 14-8 summarizes the differences between stock dividends and stock splits.

Illustration 14-8

Differences between the effects

of stock dividends and stock

splits

Total retained earnings Decrease No changeTotal par value (common stock) Increase No change

Total stockholders’ equity No change No change

$97,000 and the class B sold for about

$3,200 per share Because the price per share is so high, the stock does not trade as frequently as the stock of other companies Buffett has always opposed stock splits because he feels that a lower stock price attracts short-

Dietmar Klement/

iStockphoto

Berkshire Hathaway Investor Insight

term investors He appears to be correct For example, while more than 6 million shares of IBM are exchanged

on the average day, only about 1,000 class A shares of

Berkshire are traded Despite Buffett’s aversion to splits, in

order to accomplish a recent acquisition, Berkshire decided

to split its class B shares 50 to 1

Source: Scott Patterson, “Berkshire Nears Smaller Baby B’s,” Wall Street Journal Online (January 19, 2010).

Why does Warren Buffett usually oppose stock splits?

(Go to WileyPLUS for this answer and additional

of each option on retained earnings, total stockholders’ equity, shares outstanding, and

par value per share

Solution

DO IT! 2 Stock Dividends and Stock Splits

Related exercise material: BE14-3, BE14-4, E14-4, E14-5, E14-6, E14-7, and DO IT! 14-2.

number of new shares

times the market price

of the stock (or par

value for a large stock

dividend).

✔ Recall that a stock

dividend increases the

number of shares

without affecting total

stockholders’ equity.

✔ Recall that a stock

split only increases the

number of shares

outstanding and

decreases the par

value per share.

The stock dividend amount is $2,250,000 [(500,000 3 10%) 3 $45] The new balance

in retained earnings is $7,750,000 ($10,000,000 2 $2,250,000) The retained earnings balance after the stock split is the same as it was before the split: $10,000,000 Total

stockholders’ equity does not change The effects on the stockholders’ equity accounts

are as follows

Original After After

Paid-in capital $ 2,000,000 $ 4,250,000 $ 2,000,000Retained earnings 10,000,000 7,750,000 10,000,000Total stockholders’ equity $12,000,000 $12,000,000 $12,000,000Shares outstanding 500,000 550,000 1,000,000

3 Prepare and analyze a comprehensive stockholders’ equity section.

LEARNING

OBJECTIVE

Retained Earnings

Retained earnings is net income that a company retains in the business The

balance in retained earnings is part of the stockholders’ claim on the total assets

of the corporation It does not, however, represent a claim on any specifi c asset

Nor can the amount of retained earnings be associated with the balance of any

asset account For example, a $100,000 balance in retained earnings does not

mean that there should be $100,000 in cash The reason is that the company may

have used the cash resulting from the excess of revenues over expenses to

pur-chase buildings, equipment, and other assets.

To demonstrate that retained earnings and cash may be quite different,

Illus-tration 14-9 shows recent amounts of retained earnings and cash in selected

companies.

Remember from Chapter 13 that when a company has net income, it closes

net income to retained earnings The closing entry is a debit to Income Summary

and a credit to Retained Earnings.

When a company has a net loss (expenses exceed revenues), it also closes

this amount to retained earnings The closing entry is a debit to Retained

Earn-ings and a credit to Income Summary To illustrate, assume that Rendle

Corpo-ration has a net loss of $400,000 in 2017 The closing entry to record this loss is

as follows.

(To close net loss to Retained Earnings)

This closing entry is done even if it results in a debit balance in Retained

Earnings Companies do not debit net losses to paid-in capital accounts To

do so would destroy the distinction between paid-in and earned capital If

cumu-lative losses exceed cumucumu-lative income over a company’s life, a debit balance in

Retained Earnings results A debit balance in Retained Earnings is identifi ed as a

defi cit A company reports a defi cit as a deduction in the stockholders’ equity

section, as shown in Illustration 14-10.

Retained earnings (defi cit) (50,000)

Total stockholders’ equity $750,000

RETAINED EARNINGS RESTRICTIONS

The balance in retained earnings is generally available for dividend declarations

In some cases, however, there may be retained earnings restrictions These make a portion of the retained earnings balance currently unavailable for divi- dends Restrictions result from one or more of the following causes.

1 Legal restrictions Many states require a corporation to restrict retained

earnings for the cost of treasury stock purchased The restriction keeps intact

the corporation’s legal capital that is being temporarily held as treasury stock

When the company sells the treasury stock, the restriction is lifted.

2 Contractual restrictions Long-term debt contracts may restrict retained

earnings as a condition for the loan The restriction limits the use of corporate assets for payment of dividends Thus, it increases the likelihood that the cor- poration will be able to meet required loan payments.

3 Voluntary restrictions The board of directors may voluntarily create retained

earnings restrictions for specifi c purposes For example, the board may rize a restriction for future plant expansion By reducing the amount of retained earnings available for dividends, the company makes more cash available for the planned expansion.

autho-Companies generally disclose retained earnings restrictions in the notes to

the fi nancial statements For example, as shown in Illustration 14-11, Tektronix Inc. , a manufacturer of electronic measurement devices, had total retained earn- ings of $774 million, but the unrestricted portion was only $223.8 million.

Certain of the Company’s debt agreements require compliance with debt covenants Management believes that the Company is in compliance with such requirements The Company had unrestricted retained earnings of $223.8 million after meeting those requirements

TEKTRONIX INC.

Notes to the Financial Statements

Real World

Illustration 14-11

Disclosure of restriction

PRIOR PERIOD ADJUSTMENTS

Suppose that a corporation has closed its books and issued fi nancial statements The corporation then discovers that it made a material error in reporting net income of a prior year How should the company record this situation in the accounts and report it in the fi nancial statements?

The correction of an error in previously issued fi nancial statements is known

as a prior period adjustment The company makes the correction directly to Retained Earnings because the effect of the error is now in this account The net income for the prior period has been recorded in retained earnings through the journalizing and posting of closing entries.

To illustrate, assume that General Microwave discovers in 2017 that it stated depreciation expense on equipment in 2016 by $300,000 due to computa- tional errors These errors overstated both net income for 2016 and the current balance in retained earnings The entry for the prior period adjustment, ignoring all tax effects, is as follows.

Companies report prior period adjustments in the retained earnings

state-ment They add (or deduct, as the case may be) these adjustments from the

begin-ning retained earbegin-nings balance This results in an adjusted beginbegin-ning balance

For example, assuming a beginning balance of $800,000 in retained earnings,

General Microwave reports the prior period adjustment as follows.

Again, reporting the correction in the current year’s income statement would be

incorrect because it applies to a prior year’s income statement.

RETAINED EARNINGS STATEMENT

The retained earnings statement shows the changes in retained earnings during

the year The company prepares the statement from the Retained Earnings account

Illustration 14-13 shows (in T-account form) transactions that affect retained

earnings.

Illustration 14-12

Statement presentation of prior period adjustments

GENERAL MICROWAVE

Retained Earnings Statement (partial)

Balance, January 1, as reported $ 800,000

Correction for overstatement of net income

in prior period (depreciation error) (300,000)

Balance, January 1, as adjusted $ 500,000

Retained Earnings

2 Prior period adjustments for 2 Prior period adjustments for

overstatement of net income understatement of net income

3 Cash dividends and stock dividends

4 Some disposals of treasury stock

Illustration 14-13

Debits and credits to retained earnings

As indicated, net income increases retained earnings, and a net loss decreases

retained earnings Prior period adjustments may either increase or decrease

retained earnings Both cash dividends and stock dividends decrease retained

earnings The circumstances under which treasury stock transactions decrease

retained earnings are explained in Chapter 13, page 586.

A complete retained earnings statement for Graber Inc., based on assumed

data, is shown in Illustration 14-14.

Correction for understatement of net income

Statement Presentation and Analysis PRESENTATION

Illustration 14-15 presents the stockholders’ equity section of Graber Inc.’s

bal-ance sheet Note the following: (1) “Common stock dividends distributable” is shown under “Capital stock” in “Paid-in capital” and (2) a note (Note R) discloses

a retained earnings restriction.

500,000 shares authorized, 400,000 shares issued and 390,000 shares outstanding $2,000,000

Common stock dividends distributable 50,000 2,050,000

Additional paid-in capital

In excess of par—preferred stock 30,000

In excess of stated value—common stock 1,050,000 Total additional paid-in capital 1,080,000

Total paid-in capital and retained earnings 4,890,000 Less: Treasury stock (10,000 common shares) 80,000

Note R: Retained earnings is restricted for the cost of treasury stock, $80,000.

Instead of presenting a detailed stockholders’ equity section in the balance

sheet and a retained earnings statement, many companies prepare a stockholders ’

equity statement This statement shows the changes (1) in each stockholders’

equity account and (2) in total that occurred during the year An example of

a stockholders’ equity statement appears in Apple ’s fi nancial statements in

end-of-the-tively Its net income was $4,687 million, and no preferred stock was outstanding

The return on common stockholders’ equity is computed as follows.

As shown above, if a company has preferred stock, we would deduct the

amount of preferred dividends from the company’s net income to compute

income available to common stockholders Also, the par value of preferred stock

is deducted from total stockholders’ equity when computing the average

com-mon stockholders’ equity.

Illustration 14-16

Return on common

stockholders’ equity

and computation

Vega Corporation has retained earnings of $5,130,000 on January 1, 2017 During the

year, Vega earned $2,000,000 of net income It declared and paid a $250,000 cash

divi-dend In 2017, Vega recorded an adjustment of $180,000 due to the understatement

(from a mathematical error) of 2016 depreciation expense Prepare a retained earnings

statement for 2017

Solution

DO IT! 3 Retained Earnings Statement

Related exercise material: BE14-5, BE14-6, E14-8, E14-9, and DO IT! 14-3.

Action Plan

✔ Recall that a retained earnings statement begins with retained earnings, as reported

at the end of the previous year.

✔ Add or subtract any prior period adjust- ments to arrive at the adjusted beginning

fi gure.

✔ Add net income and subtract dividends declared to arrive at the ending balance in retained earnings.

VEGA CORPORATION

Retained Earnings StatementFor the Year Ended December 31, 2017

Balance, January 1, as reported $5,130,000

Correction for overstatement of net income

in prior period (depreciation error) (180,000)

Balance, January 1, as adjusted 4,950,000

Income Statement Presentation

Income statements for corporations are the same as the statements for

pro-prietorships or partnerships except for one thing: the reporting of income

taxes For income tax purposes, corporations are a separate legal entity As a

result, corporations report income tax expense in a separate section of the

cor-poration income statement, before net income The condensed income statement

for Leads Inc in Illustration 14-17 (page 624) shows a typical presentation Note

that the corporation reports income before income taxes as one line item and

income tax expense as another.

5 Return on Common Preferred Dividends Stockholders’ Equity Stockholders’ Equity

($4,687 2 $0) 4 ($31,820 1 $30,753)

2

Companies record income tax expense and the related liability for income taxes payable as part of the adjusting process Using the data for Leads Inc., in Illustration 14-17, the adjusting entry for income tax expense at December 31,

Income before income taxes 156,000 Income tax expense 46,800

(To record income taxes for 2017)

The income statement of Apple (in Appendix A) presents another illustration

of income taxes.

Income Statement Analysis

The fi nancial press frequently reports earnings data Stockholders and potential investors widely use these data in evaluating the profi tability of a company A convenient measure of earnings is earnings per share (EPS) , which indicates

the net income earned by each share of outstanding common stock.

EPS AND PREFERRED DIVIDENDS

The existence of preferred dividends slightly complicates the calculation of EPS When a corporation has both preferred and common stock, we must subtract the

current year’s preferred dividend from net income, to arrive at income available to common stockholders Illustration 14-18 shows the formula for computing EPS.

ETHICS NOTE

In order to meet market

expectations for EPS,

some managers engage

in elaborate treasury

stock transactions These

transactions can be very

costly for the remaining

shareholders

Illustration 14-18

Formula for earnings per share Net Income Weighted-Average Earnings

Preferred Dividends Shares Outstanding Share

To illustrate, assume that Rally Inc reports net income of $211,000 on its 102,500 weighted-average common shares.1 During the year, it also declares a

$6,000 dividend on its preferred stock Therefore, the amount Rally has available for common stock dividends is $205,000 ($211,000 2 $6,000) Earnings per share

is $2 ($205,000 4 102,500) If the preferred stock is cumulative, Rally deducts the dividend for the current year, whether or not it is declared Remember that com-

panies report earnings per share only for common stock.

Investors often attempt to link earnings per share to the market price per

share of a company’s stock.2 Because of the importance of earnings per share,

most companies must report it on the face of the income statement Generally,

companies simply report this amount below net income on the statement For

Rally Inc., the presentation is as follows.

2The ratio of the market price per share to the earnings per share is called the price/earnings (P/E)

ratio The fi nancial media report this ratio for common stocks listed on major stock exchanges.

Earnings per share $2.00

The Impact of Corporate Social Responsibility

A recent survey conducted by Institutional Shareholder Services, a proxy advisory fi rm, shows that 83% of investors now believe environmental and social factors can signifi cantly impact shareholder value over the long term This belief is clearly visible in the rising level of support for shareholder proposals requesting action related to social and environmental issues

The following table shows that the number of corporate social responsibility (CSR)-related shareholder proposals rose from 150 in 2000 to 191 in 2010 Moreover, those proposals received average voting support of 18.4% of votes cast versus just 7.5% a decade earlier

Source: Investor Responsibility Research Center, Ernst & Young, Seven Questions CEOs and Boards Should Ask About: “Triple Bottom Line” Reporting.

Why are CSR-related shareholder proposals increasing? (Go to WileyPLUS for this answer and

Percent proposals receiving 10% support 16.7% 31.2% 52.1%

On January 1, 2017, Siena Corporation purchased 2,000 shares of treasury stock Other

information regarding Siena Corporation is provided below

Weighted-average number of shares outstanding 10,000 8,000*

Common stockholders’ equity, beginning of year $500,000 $400,000*

Common stockholders’ equity, end of year $500,000 $400,000

*Adjusted for purchase of treasury stock

Compute (a) return on common stockholders’ equity for each year and (b) earnings per

share for each year, and (c) discuss the changes in each

DO IT! 4 Stockholders’ Equity and EPS

per share by dividing

net income available to

($500,000 1 $500,000)/2 ($400,000 1 $400,000)/2 holders’ equity

(b)Earnings per ($110,000 2 $10,000)

5 $10 ($110,000 2 $10,000) 5 $12.50

(c) Between 2016 and 2017, return on common stockholders’ equity improved from 20% to 25% Earnings per share increased from $10 to $12.50 While this would appear to be good news for the company’s common stockholders, these increases should be carefully evaluated It is important to note that net income did not change during this period The increase in both ratios was due to the purchase of treasury shares, which reduced the denominator of each ratio As the company repurchases its own shares, it becomes more reliant on debt and thus increases its risk

Explain how to account for cash dividends. Companies

make entries for cash dividends at the declaration

date and at the payment date At the declaration

date, the entry is debit Cash Dividends and credit

Dividends Payable At the payment date, the entry is

debit Dividends Payable and credit Cash

Explain how to account for stock dividends and

splits At the declaration date, the entry for a small

stock dividend is debit Stock Dividends, credit

Paid-in Capital in Excess of Par (or Stated Value)—

Common Stock, and credit Common Stock Dividends

Distributable

At the payment date, the entry for a small stock

dividend is debit Common Stock Dividends

Distribut-able and credit Common Stock A stock split reduces

the par or stated value per share and increases the

number of shares but does not affect balances in

stockholders’ equity accounts.

Prepare and analyze a comprehensive stockholders’

equity section. Companies report each of the

individ-ual debits and credits to retained earnings in the

retained earnings statement Additions consist of net

income and prior period adjustments to correct

under-statements of prior years’ net income Deductions

2

3

consist of net loss, prior period adjustments to correct

overstatements of prior years’ net income, cash and

stock dividends, and some disposals of treasury stock

A comprehensive stockholders’ equity section includes all stockholders’ equity accounts It consists

of two sections: paid-in capital and retained earnings

It should also include notes to the fi nancial ments that explain any restrictions on retained earn-ings and any dividends in arrears One measure of

state-profi tability is the return on common stockholders’

equity It is calculated by dividing net income minus preferred stock dividends by average common stock-

holders’ equity.

Describe the form and content of corporation income statements The form and content of corporation income statements are similar to the statements of proprietorships and partnerships with one exception: Corporations must report income taxes or income tax expense in a separate section before net income in the income statement

Companies compute earnings per share by ing net income by the weighted-average number of common shares outstanding during the period When preferred stock dividends exist, they must be deducted from net income in order to calculate EPS

Cash dividend A pro rata distribution of cash to

stock-holders (p 610)

Cumulative dividend A feature of preferred stock

enti-tling the stockholder to receive current-year and any

unpaid prior-year dividends before common

stockhold-ers are paid dividends (p 612)

Declaration date The date the board of directors

for-mally declares (authorizes) a dividend and announces

it to stockholders (p 611)

Defi cit A debit balance in retained earnings (p 619)

Dividend A corporation’s distribution of cash or stock

to its stockholders on a pro rata (proportional) basis

(p 610)

Earnings per share The net income earned by each

share of outstanding common stock (p 624)

Liquidating dividend A dividend declared out of paid-in

capital (p 610)

Payment date The date dividends are transferred to

stockholders (p 611)

Prior period adjustment The correction of an error in

previously issued fi nancial statements (p 620)

Record date The date when ownership of outstanding

shares is determined for dividend purposes (p 611)

Retained earnings Net income that a company retains

in the business (p 619)

Retained earnings restrictions Circumstances that make a portion of retained earnings currently unavail-able for dividends (p 620)

Retained earnings statement A fi nancial statement that shows the changes in retained earnings during the year (p 621)

Return on common stockholders’ equity A measure

of profi tability that shows how many dollars of net income were earned for each dollar invested by the owners; computed as net income minus preferred divi-

dends divided by average common stockholders’ equity

(p 622)

Stock dividend A pro rata distribution to stockholders

of the corporation’s own stock (p 615).

Stockholders’ equity statement A statement that shows

the changes in each stockholders’ equity account and in total stockholders’ equity during the year

1 Entries for cash dividends are required on the:

(a) declaration date and the payment date

(b) record date and the payment date

(c) declaration date, record date, and payment date

(d) declaration date and the record date

2 Preferred stock may have priority over common stock

except in:

(a) dividends

(b) assets in the event of liquidation

(c) cumulative dividend features

(d) voting

3. Encore Inc declared an $80,000 cash dividend It

cur-rently has 3,000 shares of 7%, $100 par value

cumula-tive preferred stock outstanding It is one year in

arrears on its preferred stock How much cash will

Encore distribute to the common stockholders?

(a) $38,000 (c) $59,000

(b) $42,000 (d) None

4. Which of the following statements about small stock

dividends is true?

(a) A debit to Retained Earnings for the par value of

the shares issued should be made

(b) A small stock dividend decreases total

stock-holders’ equity

(c) Market price per share should be assigned to the

dividend shares

(d) A small stock dividend ordinarily will have an

effect on par value per share of stock

(LO 1)

(LO 1)

(LO 1)

(LO 2)

5. Which of the following statements about a 3-for-1

stock split is true?

(a) It will triple the market price of the stock

(b) It will triple the amount of total stockholders’ equity

(c) It will have no effect on total stockholders’ equity.(d) It requires the company to distribute cash

6. Raptor Inc has retained earnings of $500,000 and total stockholders’ equity of $2,000,000 It has 100,000 shares of $8 par value common stock outstanding, which is currently selling for $30 per share If Raptor declares a 10% stock dividend on its common stock:

(a) net income will decrease by $80,000

(b) retained earnings will decrease by $80,000 and total stockholders’ equity will increase by $80,000.(c) retained earnings will decrease by $300,000 and total stockholders’ equity will increase by

(a) State laws regarding treasury stock

(b) Long-term debt contract terms

(c) Authorizations by the board of directors in light

of planned expansion of corporate facilities

(d) All of these answer choices are correct

8 All but one of the following is reported in a retained

earnings statement The exception is:

(a) cash and stock dividends

(b) net income and net loss

(c) sales revenue

(d) prior period adjustments

9. A prior period adjustment is:

(a) reported in the income statement as a nontypical

(d) reported in the retained earnings statement as an

adjustment of the ending balance of retained

earnings

10. In the stockholders’ equity section, Common Stock

Dividends Distributable is reported as a(n):

(a) deduction from total paid-in capital and retained

earnings

(b) addition to additional paid-in capital

(c) deduction from retained earnings

(d) addition to capital stock

11. The return on common stockholders’ equity is

de-fi ned as:

(a) net income divided by total assets

(b) cash dividends divided by average common

stock-holders’ equity

(c) income available to common stockholders divided

by average common stockholders’ equity

(d) None of these is correct

12. Katie Inc reported net income of $186,000 during

2017 and paid dividends of $26,000 on common

stock It also has 10,000 shares of 6%, $100 par value,

noncumulative preferred stock outstanding and paid

(a) 10.0% (c) 7.1%

(b) 9.0% (d) 13.3%

13. During 2017, Talon Inc had sales revenue $376,000, gross profi t $176,000, operating expenses $66,000, cash dividends $30,000, other expenses and losses

$20,000 Its corporate tax rate is 30% What was Talon’s income tax expense for the year?

(a) gross profi t (c) operating income

(b) income tax expense (d) net sales

15. If everything else is held constant, earnings per share

share-(c) the issuance of new shares of common stock

(d) the purchase of treasury stock

16. The income statement for Nadeen, Inc shows income before income taxes $700,000, income tax expense

$210,000, and net income $490,000 If Nadeen has 100,000 shares of common stock outstanding through-out the year, earnings per share is:

1 (a) Entries are required for dividends on the declaration date and the payment date, but not the record date The other choices

are therefore incorrect

2 (d) Preferred stock usually does not have voting rights and therefore does not have priority over common stock on this issue

The other choices are true statements

3 (a) The preferred stockholders will receive a total of $42,000 in dividends (3,000 3 07 3 $100 3 2 years) The common

stock-holders will receive $38,000 ($80,000 2 $42,000), not (b) $42,000, (c) $59,000, or (d) none

4 (c) Because the stock dividend is considered small, the fair value (market price), not the par value, is assigned to the shares The

other choices are incorrect because (a) a debit to Retained Earnings for the fair value of the shares issued should be made; (b) a

small stock dividend changes the composition of total stockholders’ equity, but does not change the total; and (d) a small stock

dividend will have no effect on par value per share

5 (c) Stock splits have no effect on total paid-in capital, retained earnings, or total stockholders’ equity The other choices are

incorrect because (a) stock splits reduce the market price per share of stock, (b) stock splits have no effect on total stockholders’

equity, and (d) the company will distribute additional shares of stock, not cash

6 (d) Retained earnings will decrease by $300,000 and total paid-in capital will increase by $300,000 The other choices are

there-fore incorrect because (a) net income is not affected, (b) retained earnings decreases by $300,000, and (c) total stockholders’ equity

does not change

7 (d) All of the answer choices are correct Although choices (a), (b), and (c) are true statements, choice (d) is the better answer.

8 (c) Sales revenue is not reported on the retained earnings statement The other choices are true statements.

9 (b) A prior period adjustment is a correction of an error that is recorded directly to retained earnings The other choices are

incorrect because a prior period adjustment is reported in the retained earnings statement, not in the (a) income statement or

(c) stockholders’ equity section of the balance sheet Choice (d) is incorrect because the prior period adjustment is an adjustment

of the beginning, not the ending, balance of retained earnings

10 (d) Common Stock Dividends Distributable is reported as an addition to capital stock, not (a) as a deduction from total paid-in

capital and retained earnings, (b) as an addition to additional paid-in capital, or (c) as a deduction from retained earnings

11 (c) Return on common stockholders’ equity equals Net income less Preferred dividends (income available to common

stock-holders) divided by Average common stockholders’ equity The other choices are therefore incorrect.

12 (b) Return on common stockholders’ equity is Net income available to common stockholders divided by Average common

stock-holders’ equity Net income available to common stockholders is Net income less Preferred dividends 5 $126,000 [$186,000 2 (10,000 3 06 3 $100)] The company’s return on common stockholders’ equity for the year is therefore 9.0% [$126,000/ ($1,200,000 1

$l,600,000)/2)], not (a) 10.0%, (c) 7.1%, or (d) 13.3%

13 (d) Income before income taxes 5 Gross profi t ($176,000) 2 Operating expenses ($66,000) 2 Other expenses and losses

($20,000) 5 $90,000 Talon’s income tax expense therefore 5 $27,000 ($90,000 3 30), not (a) $18,000, (b) $52,800, or (c) $112,800.

14 (b) Corporation income statements report income tax expense but income statements for unincorporated fi rms do not The

other choices are true statements

15 (d) Earnings per share is increased by the purchase of treasury stock because the denominator (the weighted-average common

shares outstanding) would decrease with this transaction The other choices are incorrect because (a) earnings per share is unchanged by the payment of a cash dividend to common shareholders; (b) earnings per share is decreased, not increased, by the payment of a cash dividend to preferred shareholders; and (c) earnings per share is decreased by the issuance of new shares of common stock

16 (b) Earnings per share equals Net income ($700,000 2 $210,000) less Preferred dividends ($0) divided by Weighted-average

common shares outstanding (100,000) 5 $4.90 per share The other choices are therefore incorrect

1 At December 31, 2017, Lebron Company distributes $50,000 of cash dividends Its

out-standing common stock has a par value of $400,000, and its 6% preferred stock has a par

value of $100,000 at December 31, 2017

Instructions

(a) Show the allocation of dividends to each class of stock, assuming that the preferred

stock dividend is 6% and not cumulative

(b) Show the allocation of the dividends to each class of stock, assuming the preferred

stock dividend of 6% is cumulative and Lebron Company did not pay any dividends on

the preferred stock in the preceding 2 years

(c) Journalize the declaration of the cash dividend at December 31, 2017, assuming the

2 On January 1, Michelle Corporation had 95,000 shares of no-par common stock issued

and outstanding The stock has a stated value of $5 per share During the year, the

follow-ing occurred

Apr 1 Issued 55,000 additional shares of common stock for $17 per share

June 15 Declared a cash dividend of $1 per share to stockholders of record on June 30

July 10 Paid the $1 cash dividend

Dec 1 Issued 2,000 additional shares of common stock for $19 per share

15 Declared a cash dividend on outstanding shares of $1.20 per share to

stockholders of record on December 31

Journalize cash dividends; indicate statement presentation.

(LO 1, 3)

Total dividend declaration $50,000

Allocation to preferred stock (6% 3 $100,000) (6,000)

Remainder to common stock $44,000

Total dividend declaration $50,000

Allocation to preferred stock (6% 3 $100,000 3 3) (18,000)

Remainder to common stock $32,000

(c) Dec 31 Cash Dividends 50,000

Solution

(a) Prepare the entries, if any, on each of the three dividend dates

(b) How are dividends and dividends payable reported in the fi nancial statements

pre-pared at December 31?

3 Oswald Company reported retained earnings at December 31, 2016, of $400,000 Oswald had 200,000 shares of common stock outstanding throughout 2017

The following transactions occurred during 2017

1 An error was discovered; in 2015, insurance expense was recorded at $90,000, but the correct amount was $60,000

2 A cash dividend of $0.50 per share was declared and paid

3 A 5% stock dividend was declared and distributed when the market price per share was

$18 per share

4 Net income was $310,000

Instruction

Prepare a retained earnings statement for 2017

Prepare a retained earnings

(b) In the retained earnings statement, dividends of $332,400 will be deducted In the balance

sheet, Dividends Payable of $182,400 will be reported as a current liability

Solution

Solution

On January 1, 2017, Hayslett Corporation had the following stockholders’ equity accounts.

Common Stock ($10 par value, 260,000 shares issued

Paid-in Capital in Excess of Par—Common Stock 1,500,000

Prepare dividend entries and

stockholders’ equity section.

During the year, the following transactions occurred.

April 1 Declared a $1.50 cash dividend per share to stockholders of record on April 15,

payable May 1

May 1 Paid the dividend declared in April

June 1 Announced a 2-for-1 stock split Prior to the split, the market price per share

was $24

Aug 1 Declared a 10% stock dividend to stockholders of record on August 15,

distrib-utable August 31 On August 1, the market price of the stock was $10 per

share

31 Issued the shares for the stock dividend

Dec 1 Declared a $1.50 per share dividend to stockholders of record on December 15,

payable January 5, 2018

31 Determined that net income for the year was $600,000

Instructions

(a) Journalize the transactions and the closing entries for net income, stock dividends,

and cash dividends

(b) Prepare a stockholders’ equity section at December 31.

(a) Apr 1 Cash Dividends (260,000 3 $1.50) 390,000

May 1 Dividends Payable 390,000

June 1 No journal entry needed for stock split

Aug 1 Stock Dividends (52,000* 3 $10) 520,000

Common Stock Dividends Distributable (52,000 3 $5) 260,000 Paid-in Capital in Excess of

Common stock, $5 par value, 572,000

shares issued and outstanding $2,860,000

Paid-in capital in excess of par—common stock 1,760,000

Total paid-in capital 4,620,000

Total stockholders’ equity $6,652,000

*$3,200,000 1 $600,000 2 $390,000 2 $520,000 2 $858,000

Brief Exercises, Exercises, DO IT! Exercises, and Problems and many additional resources are available for practice in WileyPLUS

QUESTIONS

1 (a) What is a dividend? (b) “Dividends must be paid

in cash.” Do you agree? Explain

2. Jan Kimler maintains that adequate cash is the only

requirement for the declaration of a cash dividend Is

Jan correct? Explain

3 (a) Three dates are important in connection with

cash dividends Identify these dates, and explain

their signifi cance to the corporation and its

stock-holders

(b) Identify the accounting entries that are made for

a cash dividend and the date of each entry

4. Farley Inc declares a $55,000 cash dividend on

December 31, 2017 The required annual dividend on

preferred stock is $10,000 Determine the allocation

of the dividend to preferred and common stockholders

assuming the preferred stock is cumulative and dividends

are 1 year in arrears

5. Contrast the effects of a cash dividend and a stock

dividend on a corporation’s balance sheet.

6 Rich Mordica asks, “Since stock dividends don’t

change anything, why declare them?” What is your

answer to Rich?

7. Gorton Corporation has 30,000 shares of $10 par

value common stock outstanding when it announces

a 2-for-1 stock split Before the split, the stock had a

market price of $120 per share After the split, how

many shares of stock will be outstanding? What will

be the approximate market price per share?

8 The board of directors is considering either a stock

split or a stock dividend They understand that total

stockholders’ equity will remain the same under

either action However, they are not sure of the different

effects of the two types of actions on other aspects of

stockholders’ equity Explain the differences to the

directors

9. What is a prior period adjustment, and how is it reported in the fi nancial statements?

10 NAJ Corporation has a retained earnings balance of

$230,000 on January 1 During the year, a prior period adjustment of $50,000 is recorded because of the understatement of depreciation in the prior period Show the retained earnings statement presentation of these data

11. What is the purpose of a retained earnings tion? Identify the possible causes of retained earnings restrictions

restric-12. How are retained earnings restrictions generally reported in the fi nancial statements?

13. Identify the events that result in debits and credits to retained earnings

14. Rafy Furcal believes that both the beginning and ing balances in retained earnings are shown in the

end-stockholders’ equity section Is Rafy correct? Discuss.

15. Dean Percival, who owns many investments in

com-mon stock, says, “I don’t care what a company’s net

income is The stock price tells me everything I need

to know!” How do you respond to Dean?

16. What is the unique feature of a corporation income statement? Illustrate this feature, using assumed data

17. Why must preferred stock dividends be subtracted from net income in computing earnings per share?

18 What were the amounts of basic earnings per share of common stock that Apple reported in the years 2009

to 2013?

BRIEF EXERCISES

declares a $1 per share cash dividend on November 1 to stockholders of record on ber 1 The dividend is paid on December 31 Prepare the entries on the appropriate dates

Decem-to record the declaration and payment of the cash dividend

BE14-2 M Bot Corporation has 10,000 shares of 8%, $100 par value, cumulative

pre-ferred stock outstanding at December 31, 2017 No dividends were declared in 2015 or

2016 If M Bot wants to pay $375,000 of dividends in 2017, what amount of dividends will common stockholders receive?

BE14-3 Langley Corporation has 50,000 shares of $10 par value common stock ing It declares a 15% stock dividend on December 1 when the market price per share is

outstand-$16 The dividend shares are issued on December 31 Prepare the entries for the tion and issuance of the stock dividend

declara-BE14-4 The stockholders’ equity section of Pretzer Corporation consists of common stock

($10 par) $2,000,000 and retained earnings $500,000 A 10% stock dividend (20,000 shares)

Prepare entries for a cash

is declared when the market price per share is $14 Show the before-and-after effects of

the dividend on the following

(a) The components of stockholders’ equity.

(b) Shares outstanding.

(c) Par value per share.

BE14-5 For the year ending December 31, 2017, Soto Inc reports net income $170,000

and dividends $85,000 Prepare the retained earnings statement for the year assuming the

balance in retained earnings on January 1, 2017, was $220,000

BE14-6 The balance in retained earnings on January 1, 2017, for Palmer Inc was $800,000

During the year, the corporation paid cash dividends of $90,000 and distributed a stock

dividend of $8,000 In addition, the company determined that it had understated its

insur-ance expense in prior years by $50,000 Net income for 2017 was $120,000 Prepare the

retained earnings statement for 2017

BE14-7 SUPERVALU, one of the largest grocery retailers in the United States, is

head-quartered in Minneapolis Suppose the following fi nancial information (in millions) was

taken from the company’s 2017 annual report: net sales $40,597, net income $393,

begin-ning common stockholders’ equity $2,581, and ending common stockholders’ equity

$2,887 Compute the return on common stockholders’ equity.

BE14-8 Whetzel Corporation reported net income of $152,000, declared dividends on

common stock of $50,000, and had an ending balance in retained earnings of $360,000

Common stockholders’ equity was $700,000 at the beginning of the year and $820,000 at

the end of the year Compute the return on common stockholders’ equity.

BE14-9 The following information is available for Reinsch Corporation for the year ended

December 31, 2017: cost of goods sold $205,000, sales revenue $350,000, other revenues

and gains $50,000, and operating expenses $75,000 Assuming a corporate tax rate of 30%,

prepare an income statement for the company

BE14-10 Ziegler Corporation reports net income of $380,000 and a weighted-average of

200,000 shares of common stock outstanding for the year Compute the earnings per share

of common stock

BE14-11 Income and common stock data for Ziegler Corporation are presented in BE14-10

Assume also that Ziegler has cumulative preferred stock dividends for the current year of

$30,000 that were declared and paid Compute the earnings per share of common stock

Prepare a retained earnings statement.

(LO 3)

Prepare a retained earnings statement.

(LO 3)

Calculate the return on

common stockholders’ equity.

(LO 3)

Compute the return on

common stockholders’ equity.

(LO 4)

Herr Corporation has 3,000 shares of 7%, $100 par value preferred stock

out-standing at December 31, 2017 At December 31, 2017, the company declared a $105,000

cash dividend Determine the dividend paid to preferred stockholders and common

stock-holders under each of the following scenarios

1 The preferred stock is noncumulative, and the company has not missed any dividends

in previous years

2 The preferred stock is noncumulative, and the company did not pay a dividend in each

of the two previous years

3 The preferred stock is cumulative, and the company did not pay a dividend in each of

the two previous years

Jurgens Company has had 4 years of net income Due to this success, the

market price of its 400,000 shares of $3 par value common stock has increased from $12

per share to $46 During this period, paid-in capital remained the same at $2,800,000

Re-tained earnings increased from $1,800,000 to $12,000,000 President E Rife is considering

either a 15% stock dividend or a 2-for-1 stock split He asks you to show the

before-and-after effects of each option on (a) retained earnings and (b) total stockholders’ equity.

Foley Corporation has retained earnings of $3,100,000 on January 1, 2017

During the year, Foley earned $1,200,000 of net income It declared and paid a $150,000

Determine dividends paid

to preferred and common stockholders.

cash dividend In 2017, Foley recorded an adjustment of $110,000 due to the ment (from mathematical error) of 2016 depreciation expense Prepare a retained earn-ings statement for 2017.

overstate-On January 1, 2017, Vahsholtz Corporation purchased 5,000 shares of sury stock Other information regarding Vahsholtz Corporation is provided as follows

Weighted-average number of common shares outstanding 50,000 45,000Common stockholders’ equity beginning of year $600,000 $750,000Common stockholders’ equity end of year $750,000 $830,000

Compute (a) return on common stockholders’ equity for each year and (b) earnings per

share for each year, and (c) discuss the changes in each

Compute return on

stockholders’ equity and EPS

and discuss changes in each.

(LO 4)

DO IT! 14-4

EXERCISES

issued and outstanding The stock has a stated value of $5 per share During the year, the following occurred

Apr 1 Issued 25,000 additional shares of common stock for $17 per share

June 15 Declared a cash dividend of $1 per share to stockholders of record on June 30

July 10 Paid the $1 cash dividend

Dec 1 Issued 2,000 additional shares of common stock for $19 per share

15 Declared a cash dividend on outstanding shares of $1.20 per share to

stockholders of record on December 31

Instructions

(a) Prepare the entries to record these transactions

(b) How are dividends and dividends payable reported in the fi nancial statements pared at December 31?

pre-E14-2 Knudsen Corporation was organized on January 1, 2016 During its fi rst year, the corporation issued 2,000 shares of $50 par value preferred stock and 100,000 shares of $10 par value common stock At December 31, the company declared the following cash divi-dends: 2016, $5,000; 2017, $12,000; and 2018, $28,000

(c) Journalize the declaration of the cash dividend at December 31, 2018, under part (b)

E14-3 On January 1, 2017, Frontier Corporation had $1,000,000 of common stock standing that was issued at par It also had retained earnings of $750,000 The company issued 40,000 shares of common stock at par on July 1 and earned net income of $400,000 for the year

out-Instructions

Journalize the declaration of a 15% stock dividend on December 10, 2017, for the ing independent assumptions

follow-(a) Par value is $10, and market price is $18

(b) Par value is $5, and market price is $20

E14-4 On October 31, the stockholders’ equity section of Heins Company consists of common stock $500,000 and retained earnings $900,000 Heins is considering the following two courses of action: (1) declaring a 5% stock dividend on the 50,000, $10 par value shares outstanding, or (2) effecting a 2-for-1 stock split that will reduce par value to $5 per share The current market price is $14 per share

Journalize cash dividends;

indicate statement

presentation.

(LO 1)

Allocate cash dividends to

preferred and common stock.

(LO 1)

Journalize stock dividends.

(LO 2)

Compare effects of a stock

dividend and a stock split.

(LO 2)

Prepare a tabular summary of the effects of the alternative actions on the components of

stockholders’ equity, outstanding shares, and par value per share Use the following column

headings: Before Action, After Stock Dividend, and After Stock Split

E14-5 On October 1, Little Bobby Corporation’s stockholders’ equity is as follows

Paid-in capital in excess of par—common stock 25,000

Total stockholders’ equity $580,000

On October 1, Little Bobby declares and distributes a 10% stock dividend when the market

price of the stock is $15 per share

Instructions

(a) Compute the par value per share (1) before the stock dividend and (2) after the stock

dividend

(b) Indicate the balances in the three stockholders’ equity accounts after the stock dividend

shares have been distributed

E14-6 During 2017, Roblez Corporation had the following transactions and events

1 Declared a cash dividend

2 Issued par value common stock for cash at par value

3 Completed a 2-for-1 stock split in which $10 par value stock was changed to $5 par

value stock

4 Declared a small stock dividend when the market price was higher than par value

5 Made a prior period adjustment for overstatement of net income

6 Issued the shares of common stock required by the stock dividend declaration in item

no 4 above

7 Paid the cash dividend in item no 1 above

8 Issued par value common stock for cash above par value

Instructions

Indicate the effect(s) of each of the foregoing items on the subdivisions of stockholders’

equity Present your answer in tabular form with the following columns Use (I) for

increase, (D) for decrease, and (NE) for no effect Item no 1 is given as an example

E14-7 Before preparing fi nancial statements for the current year, the chief accountant for

Toso Company discovered the following errors in the accounts

1 The declaration and payment of $50,000 cash dividend was recorded as a debit to Interest

Expense $50,000 and a credit to Cash $50,000

2 A 10% stock dividend (1,000 shares) was declared on the $10 par value stock when the

market price per share was $18 The only entry made was Stock Dividends (Dr.) $10,000

and Dividend Payable (Cr.) $10,000 The shares have not been issued

3 A 4-for-1 stock split involving the issue of 400,000 shares of $5 par value common stock

for 100,000 shares of $20 par value common stock was recorded as a debit to Retained

Earnings $2,000,000 and a credit to Common Stock $2,000,000

Instructions

Prepare the correcting entries at December 31

E14-8 On January 1, 2017, Eddy Corporation had retained earnings of $650,000 During

the year, Eddy had the following selected transactions

1 Declared cash dividends $120,000

2 Corrected overstatement of 2016 net income because of inventory error $40,000

3 Earned net income $350,000

4 Declared stock dividends $90,000

Instructions

Prepare a retained earnings statement for the year

Indicate account balances after a stock dividend.

E14-9 Newland Company reported retained earnings at December 31, 2016, of $310,000 Newland had 200,000 shares of common stock outstanding at the beginning of 2017.The following transactions occurred during 2017.

1 An error was discovered In 2015, depreciation expense was recorded at $70,000, but the correct amount was $50,000

2 A cash dividend of $0.50 per share was declared and paid

3 A 5% stock dividend was declared and distributed when the market price per share was

$15 per share

4 Net income was $285,000

Instructions

Prepare a retained earnings statement for 2017

E14-10 Dirk Company reported the following balances at December 31, 2016: common stock $500,000, paid-in capital in excess of par value—common stock $100,000, and retained earnings $250,000 During 2017, the following transactions affected stockholders’ equity

1 Issued preferred stock with a par value of $125,000 for $200,000

2 Purchased treasury stock (common) for $40,000

3 Earned net income of $180,000

4 Declared and paid cash dividends of $56,000

Instructions

Prepare the stockholders’ equity section of Dirk Company’s December 31, 2017, balance sheet

E14-11 The following accounts appear in the ledger of Horner Inc after the books are closed at December 31

Common Stock, no par, $1 stated value, 400,000 shares authorized;

Paid-in Capital in Excess of Stated Value—Common Stock 1,200,000Preferred Stock, $5 par value, 8%, 40,000 shares authorized;

Paid-in Capital in Excess of Par—Preferred Stock 344,000

Instructions

(a) Prepare a corporate income statement

(b) Calculate earnings per share

E14-13 In 2017, Pennington Corporation had net sales of $600,000 and cost of goods sold

of $360,000 Operating expenses were $153,000, and interest expense was $7,500 The corporation’s tax rate is 30% The corporation declared preferred dividends of $15,000 in

2017, and its average common stockholders’ equity during the year was $200,000

Instructions

(a) Prepare an income statement for Pennington Corporation

(b) Compute Pennington Corporation’s return on common stockholders’ equity for 2017

E14-14 Ringgold Corporation has outstanding at December 31, 2017, 50,000 shares of

$20 par value, cumulative, 6% preferred stock and 200,000 shares of $5 par value common stock All shares were outstanding the entire year During 2017, Ringgold earned total revenues of $2,000,000 and incurred total expenses (except income taxes) of $1,300,000 Ringgold’s income tax rate is 30%

Prepare a retained earnings

Prepare an income statement

and compute earnings per

share.

(LO 4)

Prepare an income statement

and compute return on

equity.

(LO 3, 4)

Compute EPS.

(LO 4)

Compute Ringgold’s 2017 earnings per share

E14-15 The following fi nancial information is available for Plummer Corporation

Average common stockholders’ equity $1,200,000 $900,000

Dividends paid to common stockholders 50,000 30,000

Dividends paid to preferred stockholders 20,000 20,000

The weighted-average number of shares of common stock outstanding was 80,000 for

Average common stockholders’ equity $1,800,000 $1,900,000

Dividends paid to common stockholders 90,000 70,000

Dividends paid to preferred stockholders 20,000 20,000

The weighted-average number of shares of common stock outstanding was 180,000 for

2016 and 150,000 for 2017

Instructions

Calculate earnings per share and return on common stockholders’ equity for 2017 and

2016

E14-17 At December 31, 2017, Millwood Corporation has 2,000 shares of $100 par value,

8%, preferred stock outstanding and 100,000 shares of $10 par value common stock

issued Millwood’s net income for the year is $241,000

Instructions

Compute the earnings per share of common stock under the following independent

situa-tions (Round to two decimals.)

(a) The dividend to preferred stockholders was declared There has been no change in the

number of shares of common stock outstanding during the year

(b) The dividend to preferred stockholders was not declared The preferred stock is

cumu-lative Millwood held 10,000 shares of common treasury stock throughout the year

Calculate ratios to evaluate earnings performance.

EXERCISES: SET B AND CHALLENGE EXERCISES

Student Companion site to access Exercises: Set B and Challenge Exercises.

During the year, the following transactions occurred.

Feb 1 Declared a $1 cash dividend per share to stockholders of record on February 15,

payable March 1

Mar 1 Paid the dividend declared in February

Apr 1 Announced a 2-for-1 stock split Prior to the split, the market price per share

was $36

July 1 Declared a 10% stock dividend to stockholders of record on July 15,

distributable July 31 On July 1, the market price of the stock was $13 per share

31 Issued the shares for the stock dividend

Dec 1 Declared a $0.50 per share dividend to stockholders of record on December 15,

(Note: Open additional stockholders’ equity accounts as needed.)

(c) Prepare a stockholders’ equity section at December 31

P14-2A The stockholders’ equity accounts of Karp Company at January 1, 2017, are as follows

Paid-in Capital in Excess of Par—Preferred Stock 200,000Paid-in Capital in Excess of Par—Common Stock 300,000

There were no dividends in arrears on preferred stock During 2017, the company had the following transactions and events

July 1 Declared a $0.60 cash dividend per share on common stock

Aug 1 Discovered $25,000 understatement of depreciation expense in 2016 (Ignore

income taxes.)Sept 1 Paid the cash dividend declared on July 1

Dec 1 Declared a 15% stock dividend on common stock when the market price of the

stock was $18 per share

15 Declared a 6% cash dividend on preferred stock payable January 15, 2018

31 Determined that net income for the year was $355,000

31 Recognized a $200,000 restriction of retained earnings for plant expansion

Instructions

(a) Journalize the transactions, events, and closing entries for net income and dividends.(b) Enter the beginning balances in the accounts, and post to the stockholders’ equity

accounts (Note: Open additional stockholders’ equity accounts as needed.)

(c) Prepare a retained earnings statement for the year

(d) Prepare a stockholders’ equity section at December 31, 2017

P14-3A The post-closing trial balance of Storey Corporation at December 31, 2017, tains the following stockholders’ equity accounts

con-Preferred Stock (15,000 shares issued) $ 750,000Common Stock (250,000 shares issued) 2,500,000Paid-in Capital in Excess of Par—Preferred Stock 250,000Paid-in Capital in Excess of Par—Common Stock 400,000Common Stock Dividends Distributable 250,000

A review of the accounting records reveals the following

1 No errors have been made in recording 2017 transactions or in preparing the closing entry for net income

2 Preferred stock is $50 par, 6%, and cumulative; 15,000 shares have been outstanding since January 1, 2016

3 Authorized stock is 20,000 shares of preferred, 500,000 shares of common with a

$10 par value

(c) Total stockholders’ equity

$2,224,000

Journalize and post

transactions; prepare retained

earnings statement and

stockholders’ equity section.

(LO 1, 2, 3)

(c) Ending balance $566,000

(d) Total stockholders’ equity

$2,898,000

Prepare retained earnings

statement and stockholders’

equity section, and compute

allocation of dividends and

earnings per share.

(LO 1, 2, 3, 4)

4 The January 1 balance in Retained Earnings was $1,170,000.

5 On July 1, 20,000 shares of common stock were issued for cash at $16 per share

6 On September 1, the company discovered an understatement error of $90,000 in

com-puting salaries and wages expense in 2016 The net of tax effect of $63,000 was

prop-erly debited directly to Retained Earnings

7 A cash dividend of $250,000 was declared and properly allocated to preferred and

com-mon stock on October 1 No dividends were paid to preferred stockholders in 2016

8 On December 31, a 10% common stock dividend was declared out of retained

earn-ings on common stock when the market price per share was $16

9 Net income for the year was $585,000

10 On December 31, 2017, the directors authorized disclosure of a $200,000 restriction of

retained earnings for plant expansion (Use Note X.)

Instructions

(a) Reproduce the Retained Earnings account (T-account) for 2017

(b) Prepare a retained earnings statement for 2017

(c) Prepare a stockholders’ equity section at December 31, 2017

(d) Compute the allocation of the cash dividend to preferred and common stock

P14-4A On January 1, 2017, Ven Corporation had the following stockholders’ equity

accounts

Common Stock (no par value, 90,000 shares issued and outstanding) $1,600,000

During the year, the following transactions occurred

Feb 1 Declared a $1 cash dividend per share to stockholders of record on February 15,

payable March 1

Mar 1 Paid the dividend declared in February

Apr 1 Announced a 3-for-1 stock split Prior to the split, the market price per share

was $36

July 1 Declared a 5% stock dividend to stockholders of record on July 15, distributable

July 31 On July 1, the market price of the stock was $16 per share

31 Issued the shares for the stock dividend

Dec 1 Declared a $0.50 per share dividend to stockholders of record on December 15,

payable January 5, 2018

31 Determined that net income for the year was $350,000

Instructions

Prepare the stockholders’ equity section of the balance sheet at (a) March 31, (b) June 30,

(c) September 30, and (d) December 31, 2017

P14-5A On January 1, 2017, Shellenburger Inc had the following stockholders’ equity

account balances

Common Stock, no-par value (500,000 shares issued) $1,500,000

Common Stock Dividends Distributable 200,000

During 2017, the following transactions and events occurred

1 Issued 50,000 shares of common stock as a result of a 10% stock dividend declared on

December 15, 2016

2 Issued 30,000 shares of common stock for cash at $6 per share

3 Corrected an error that had understated the net income for 2015 by $70,000

4 Declared and paid a cash dividend of $80,000

5 Earned net income of $300,000

Instructions

Prepare the stockholders’ equity section of the balance sheet at December 31, 2017

(c) Total stockholders’ equity

$5,192,000

Prepare the stockholders’ equity section, refl ecting dividends and stock split.

(LO 1, 2, 3)

Total stockholders’ equity

$2,770,000

PROBLEMS: SET B AND SET C

Student Companion site to access Problems: Set B and Set C.

CONTINUING PROBLEM

COOKIE CREATIONS: AN ENTREPRENEURIAL JOURNEY

(Note: This is a continuation of the Cookie Creations problem from Chapters 1 through 13.)

CC14 After establishing their company’s fi scal year-end to be October 31, Natalie and Curtis began

operating Cookie & Coffee Creations Inc on November 1, 2017 On that date, they issued both ferred and common stock After the fi rst year of operations, Natalie and Curtis want to prepare fi nan-cial information for the year

pre-Go to the book’s companion website, www.wiley.com/college/weygandt, to see the completion of this

problem.

PERSPECTIVE

FINANCIAL REPORTING AND ANALYSIS Financial Reporting Problem: Apple Inc.

BYP14-1 The fi nancial statements of Apple Inc. are presented in Appendix A Instructions for

access-ing and usaccess-ing the company’s complete annual report, includaccess-ing the notes to the fi nancial statements,

are also provided in Appendix A

Instructions

Refer to Apple’s fi nancial statements and answer the following question.

What amount, if any, did Apple declare in dividends on common stock in the year ended September 28, 2013?

Comparative Analysis Problem:

PepsiCo, Inc vs The Coca-Cola CompanyBYP14-2 PepsiCo’s fi nancial statements are presented in Appendix B Financial statements of

The Coca-Cola Company are presented in Appendix C Instructions for accessing and using the complete annual reports of PepsiCo and Coca-Cola, including the notes to the fi nancial statements, are also provided in Appendices B and C, respectively

Instructions

(a) Compute earnings per share and return on common stockholders’ equity for both companies for

2013 Assume PepsiCo’s average shares were 1,541 million and Coca-Cola’s

weighted-average shares were 4,568 million Can these measures be used to compare the profi tability of the two companies? Why or why not?

(b) What was the total amount of dividends paid by each company in 2013?

Comparative Analysis Problem:

Amazon.com, Inc vs Wal-Mart Stores, Inc.

BYP14-3 Amazon.com, Inc ’s fi nancial statements are presented in Appendix D Financial statements

of Wal-Mart Stores, Inc. are presented in Appendix E Instructions for accessing and using the plete annual reports of Amazon and Wal-Mart, including the notes to the fi nancial statements, are also provided in Appendices D and E, respectively

BYP14-4 Use the stockholders’ equity section of an annual report and identify the major components.

Address: www.annualreports.com, or go to www.wiley.com/college/weygandt

BROADENING YOUR

© leungchopan/

Shutterstock

1 From the Annual Reports Homepage, choose Search by Alphabet, and choose a letter.

2 Select a particular company

3 Choose Annual Report

4 Follow instructions below

Instructions

Answer the following questions

(a) What is the company’s name?

(b) What classes of capital stock has the company issued?

(c) For each class of stock:

(1) How many shares are authorized, issued, and/or outstanding?

(2) What is the par value?

(d) What are the company’s retained earnings?

(e) Has the company acquired treasury stock? How many shares?

CRITICAL THINKING

Decision-Making Across the Organization

BYP14-5 The stockholders’ equity accounts of Gonzalez, Inc., at January 1, 2017, are as follows.

Preferred Stock, no par, 4,000 shares issued $400,000

Common Stock, no par, 140,000 shares issued 700,000

During 2017, the company had the following transactions and events

July 1 Declared a $0.50 cash dividend per share on common stock

Aug 1 Discovered a $72,000 overstatement of 2016 depreciation expense (Ignore income taxes.)

Sept 1 Paid the cash dividend declared on July 1

Dec 1 Declared a 10% stock dividend on common stock when the market price of the stock

was $12 per share

15 Declared a $6 per share cash dividend on preferred stock, payable January 31, 2018

31 Determined that net income for the year was $320,000

Instructions

With the class divided into groups, answer the following questions

(a) Prepare a retained earnings statement for the year There are no preferred dividends in arrears

(b) Discuss why the overstatement of 2016 depreciation expense is not treated as an adjustment of the

current year’s income.

(c) Discuss the reasons why a company might decide to issue a stock dividend rather than a cash

dividend

Communication Activity

announced a 2-for-1 stock split Your parents own 100 shares of each company’s $50 par value

com-mon stock During a recent phone call, your parents ask you, as an accounting student, to explain the

differences between the two events

Instructions

Write a letter to your parents that explains the effects of the two events on them as stockholders and

the effects of each event on the fi nancial statements of each corporation

Ethics Case

BYP14-7 Molina Corporation has paid 60 consecutive quarterly cash dividends (15 years) The last

6 months, however, have been a cash drain on the company, as profi t margins have been greatly

narrowed by increasing competition With a cash balance suffi cient to meet only day-to-day operating

needs, the president, Rob Lowery, has decided that a stock dividend instead of a cash dividend should

be declared He tells Molina’s fi nancial vice president, Debbie Oler, to issue a press release stating that

the company is extending its consecutive dividend record with the issuance of a 5% stock dividend

“Write the press release convincing the stockholders that the stock dividend is just as good as a cash

dividend,” he orders “Just watch our stock rise when we announce the stock dividend It must be a

good thing if that happens.”

• The accounting related to prior period adjustment is essentially the same under IFRS and GAAP.

• The stockholders’ equity section is essentially the same under IFRS and GAAP However, terminology

used to describe certain components is often different These differences are discussed in Chapter 13

• The income statement using IFRS is called the statement of comprehensive income A statement

of comprehensive income is presented in a one- or two-statement format The single-statement approach includes all items of income and expense, as well as each component of other comprehen-sive income or loss by its individual characteristic In the two-statement approach, a traditional income statement is prepared It is then followed by a statement of comprehensive income, which starts with net income or loss and then adds other comprehensive income or loss items Regardless

of which approach is reported, income tax expense is required to be reported

• The computations related to earnings per share are essentially the same under IFRS and GAAP

Differences

• The term reserves is used in IFRS to indicate all non–contributed (non–paid-in) capital Reserves

include retained earnings and other comprehensive income items, such as revaluation surplus and unrealized gains or losses on available-for-sale securities

• IFRS often uses terms such as retained profi ts or accumulated profi t or loss to describe retained

earnings The term retained earnings is also often used

Instructions

(a) Who are the stakeholders in this situation?

(b) Is there anything unethical about Lowery’s intentions or actions?

(c) What is the effect of a stock dividend on a corporation’s stockholders’ equity accounts? Which

would you rather receive as a stockholder—a cash dividend or a stock dividend? Why?

All About You

BYP14-8 In this textbook, you learned that in response to the Sarbanes-Oxley Act, many companies have implemented formal ethics codes Many other organizations also have ethics codes

Instructions

Obtain the ethics code from an organization that you belong to (e.g., student organization, business school, employer, or a volunteer organization) Evaluate the ethics code based on how clearly it iden-tifi es proper and improper behavior Discuss its strengths, and how it might be improved

FASB Codifi cation Activity

BYP14-9 If your school has a subscription to the FASB Codifi cation, go to http://aaahq.org/ascLogin.

cfm to log in and prepare responses to the following.

(a) What is the stock dividend?

(b) What is a stock split?

(c) At what percentage point does the issuance of additional shares qualify as a stock dividend, as opposed to a stock split?

• Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity,

capital and reserves, and shareholders’ funds.

Looking to the Future

The IASB and the FASB are currently working on a project related to fi nancial statement presentation

An important part of this study is to determine whether certain line items, subtotals, and totals should

be clearly defi ned and required to be displayed in the fi nancial statements For example, it is likely that

the statement of stockholders’ equity and its presentation will be examined closely

Both the IASB and FASB are working toward convergence of any remaining differences related to

earnings per share computations This convergence will deal with highly technical changes beyond

the scope of this textbook

IFRS Practice

IFRS Self-Test Questions

1 The basic accounting for cash dividends and stock dividends:

(a) is different under IFRS versus GAAP

(b) is the same under IFRS and GAAP

(c) differs only for the accounting for cash dividends between GAAP and IFRS

(d) differs only for the accounting for stock dividends between GAAP and IFRS

2 Which item is not considered part of reserves?

(a) Unrealized loss on available-for-sale investments

(b) Revaluation surplus

(c) Retained earnings

(d) Issued shares

3 Under IFRS, a statement of comprehensive income must include:

(a) accounts payable (c) income tax expense

(b) retained earnings (d) preference stock

4 Which set of terms can be used to describe total stockholders’ equity under IFRS?

(a) Shareholders’ equity, capital and reserves, other comprehensive income.

(b) Capital and reserves, shareholders’ equity, shareholders’ funds.

(c) Capital and reserves, retained earnings, shareholders’ equity.

(d) All of the answer choices are correct

5 Earnings per share computations related to IFRS and GAAP:

(a) are essentially similar

(b) result in an amount referred to as earnings per share

(c) must deduct preferred (preference) dividends when computing earnings per share

(d) All of the answer choices are correct

International Financial Reporting Problem: Louis Vuitton

IFRS14-1 The fi nancial statements of Louis Vuitton are presented in Appendix F Instructions for

accessing and using the company’s complete annual report, including the notes to its fi nancial

state-ments, are also provided in Appendix F

Instructions

Use the company’s annual report to answer the following questions

(a) Did the company declare and pay any dividends for the year ended December 31, 2013?

(b) Compute the company’s return on ordinary shareholders’ equity for the year ended December 31,

2013

(c) What was Louis Vuitton’s earnings per share for the year ended December 31, 2013?

Answers to IFRS Self-Test Questions

1 b 2 d 3 c 4 b 5 d

Debt can help a company acquire the things it needs to grow,

but it is often the very thing that kills a company A brief

history of Maxwell Car Company illustrates the role of debt in

the U.S auto industry In 1920, Maxwell Car Company was on

the brink of fi nancial ruin Because it was unable to pay its

bills, its creditors stepped in and took over They hired a

former General Motors (GM) executive named Walter Chrysler

to reorganize the company By 1925, he had taken over the

company and renamed it Chrysler By 1933, Chrysler was

booming, with sales surpassing even those of Ford

But the next few decades saw Chrysler make a series of

blunders By 1980, with its creditors pounding at the gates,

Chrysler was again on the brink of fi nancial ruin

At that point, Chrysler brought in a former Ford executive

named Lee Iacocca to save the company Iacocca argued that

the United States could not afford to let Chrysler fail because

of the loss of jobs He convinced the federal government to

grant loan guarantees—promises that if Chrysler failed to pay

its creditors, the government would pay them Iacocca then

streamlined operations and brought out some profi table

products Chrysler repaid all of its government-guaranteed loans by 1983, seven years ahead of the scheduled fi nal payment

To compete in today’s global vehicle market, you must be big—really big So in 1998, Chrysler merged with German automaker Daimler-Benz to form DaimlerChrysler For a time, this left just two U.S.-based auto manufacturers—GM and Ford But in 2007, DaimlerChrysler sold 81% of Chrysler to Cerberus, an investment group, to provide much-needed cash infusions to the automaker In 2009, Daimler turned over its remaining stake to Cerberus Three days later, Chrysler fi led for bankruptcy But by 2010, it was beginning to show signs

of a turnaround

The car companies are giants GM and Ford typically rank among the top fi ve U.S fi rms in total assets But GM and Ford accumulated truckloads of debt on their way to getting big Although debt made it possible to get so big, the Chrysler story, and GM’s recent bankruptcy, make it clear that debt can also threaten a company’s survival

And Then There Were Two

As you can see from the Feature Story below, having liabilities can be dangerous

in diffi cult economic times In this chapter, we will explain the accounting for the major types of

long-term liabilities reported on the balance sheet Long-long-term liabilities are obligations that are expected

to be paid more than one year in the future These liabilities may be bonds, long-term notes, or lease obligations.

• Issuing bonds at face value

• Discount or premium on bonds

• Issuing bonds at a discount

• Issuing bonds at a premium

• Redeeming and converting bonds

Learning Objectives

Long-Term Notes

DO IT! 3

• Long-term notes payable

• Mortgage notes payable

Lease Liability; Analysis

of Long-Term Liabilities

DO IT! 4

• Presentation

• Use of ratios

• Debt and equity fi nancing

• Lease liabilities and balance-sheet fi nancing

off-Go to the REVIEW AND PRACTICEsection at the end of the chapter for a review of key concepts and practice

applications with solutions

Visit WileyPLUS with ORION for additional tutorials and practice opportunities.

1 Describe the major characteristics of bonds.

LEARNING

OBJECTIVE

Long-term liabilities are obligations that a company expects to pay more than one year in the future In this chapter, we explain the accounting for the principal types of obligations reported in the long-term liabilities section of the balance sheet These obligations often are in the form of bonds or long-term notes.

Bonds are a form of interest-bearing note payable issued by corporations, universities, and governmental agencies Bonds, like common stock, are sold in small denominations (usually $1,000 or multiples of $1,000) As a result, bonds attract many investors When a corporation issues bonds, it is borrowing money The person who buys the bonds (the bondholder) is investing in bonds.

Types of Bonds

Bonds may have many different features In the following sections, we describe the types of bonds commonly issued.

SECURED AND UNSECURED BONDS

Secured bonds have specifi c assets of the issuer pledged as collateral for the bonds A bond secured by real estate, for example, is called a mortgage bond A bond secured by specifi c assets set aside to redeem (retire) the bonds is called a

sinking fund bond

Unsecured bonds , also called debenture bonds , are issued against the eral credit of the borrower Companies with good credit ratings use these bonds extensively For example, at one time DuPont reported over $2 billion of deben- ture bonds outstanding.

gen-CONVERTIBLE AND CALLABLE BONDS

Bonds that can be converted into common stock at the bondholder’s option are

convertible bonds The conversion feature generally is attractive to bond buyers Bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity are callable bonds A call feature is included in nearly all corpo- rate bond issues.

Issuing Procedures

State laws grant corporations the power to issue bonds Both the board of directors

and stockholders usually must approve bond issues In authorizing the bond issue, the board of directors must stipulate the number of bonds to be authorized, total face value, and contractual interest rate The total bond authorization often

exceeds the number of bonds the company originally issues This gives the tion the fl exibility to issue more bonds, if needed, to meet future cash requirements The face value is the amount of principal due at the maturity date The

corpora-maturity date is the date that the fi nal payment is due to the investor from the issuing company The contractual interest rate , often referred to as the stated rate, is the rate used to determine the amount of cash interest the borrower pays

and the investor receives Usually, the contractual rate is stated as an annual rate The terms of the bond issue are set forth in a legal document called a bond indenture The indenture shows the terms and summarizes the rights of the bondholders and their trustees, and the obligations of the issuing company The

trustee (usually a fi nancial institution) keeps records of each bondholder,

main-tains custody of unissued bonds, and holds conditional title to pledged property.

In addition, the issuing company arranges for the printing of bond certifi cates The indenture and the certifi cate are separate documents As shown in Illustration 15-1, a bond certifi cate provides the following information: name of the issuer, face value, contractual interest rate, and maturity date An investment company that specializes in selling securities generally sells the bonds for the issuing company.

ETHICS NOTE

Some companies try to

minimize the amount

of debt reported on

their balance sheet by

not reporting certain

types of commitments as

liabilities This subject is

of intense interest in the

Bond

“Hey Harv,

call in those

bonds”

Face or parvalue

Maturitydate

Issuer ofbonds

Determining the Market Price of a Bond

If you were an investor wanting to purchase a bond, how would you determine

how much to pay? To be more specifi c, assume that Coronet, Inc issues a

zero-interest bond (pays no zero-interest) with a face value of $1,000,000 due in 20 years

For this bond, the only cash you receive is a million dollars at the end of 20 years

Would you pay a million dollars for this bond? We hope not! A million dollars

received 20 years from now is not the same as a million dollars received today.

The term time value of money is used to indicate the relationship between

time and money—that a dollar received today is worth more than a dollar

prom-ised at some time in the future If you had $1 million today, you would invest it

From that investment, you would earn interest such that at the end of 20 years,

you would have much more than $1 million Thus, if someone is going to pay you

$1 million 20 years from now, you would want to fi nd its equivalent today, or its

present value In other words, you would want to determine the value today of the

amount to be received in the future after taking into account current interest rates.

The current market price (present value) of a bond is the value at which it

should sell in the marketplace Market price therefore is a function of the three

factors that determine present value: (1) the dollar amounts to be received,

(2) the length of time until the amounts are received, and (3) the market rate of

interest The market interest rate is the rate investors demand for loaning funds.

To illustrate, assume that Acropolis Company on January 1, 2017, issues

$100,000 of 9% bonds, due in fi ve years, with interest payable annually at

year-end The purchaser of the bonds would receive the following two types of cash

payments: (1) principal of $100,000 to be paid at maturity, and (2) fi ve $9,000